The state of the U.S. budget deficit, aging demographics, midterm elections and the cusp of earnings season.
Rising bond yields continue to be the main story in the financial markets, with anxiety only ramping after the release of the Congressional Budget Office report for the fiscal year ending Sept. 30, which showed the U.S. budget deficit climbed to nearly $2 trillion. The deficit now exceeds 6% of gross domestic product (GDP) and is up 12% (or $218 billion) from 2025. Roughly $130 billion in tariff refunds exacerbated that increase following a Supreme Court ruling that struck down certain global tariffs earlier this year.
The government is spending $7.4 trillion, up 6% year-over-year, but collecting only $5.4 trillion in revenue, up only 3% year-over-year. U.S. net interest payments exceed outlays on every spending category except Social Security. Our annual interest costs exceed the entire defense budget.
America is upside down in its financial planning.
And markets are no longer shrugging off this news, confident of our ability to grow our way out of the problem or that it is a temporary surge. If we were in a time of deep recession or coping with an economic shock like a war or pandemic, deficits like these might be necessary, but that is not the case. We have been in a time of sustained economic expansion for years. Federal borrowing has shifted from the cyclical to structural.
In my life’s work as an advisor, I have often settled clients’ nerves on this topic by arguing that the U.S. economy is the largest, most innovative and resilient in the world, and that no fixed debt-to-GDP level automatically triggers a crisis. America can run higher deficits because it is, well, America. We have a vibrant, thriving economy with structured methods to raise taxes, generate revenue and cut expenses when and if needed in a crisis.
But that argument has holes these days. Consider that by 2030 roughly 20% of Americans will be 65 or older, according to the U.S. Census Bureau. At the same time, the cost of health care per Medicare enrollee keeps climbing. Also, the cost of debt service continues to climb. The Congressional Budget Office projects interest payments on an annual basis will more than double over the next decade, totaling roughly $16 trillion from 2026 through 2035. This means one out of every six federal dollars will be spent on debt service.
Revenue growth remains constrained, holding near historical norms even as structural spending obligations grow faster than the economy.
A lack of political will to cut spending or raise tax revenue, combined with rising interest rates after a decade of financial repression, unfavorable demographics and slower growth, is coming to roost. With a fiscal path less anchored than in the past, markets are demanding more compensation for the accumulated risks we are running.
Does this mean we should head for the hills? Notwithstanding all the negatives here, the risk of a U.S. debt default is extremely low. U.S. debt is still in high demand and boasts a long record of institutional credibility. Our economy is multifaceted and innovative, while our financial markets and systems are the largest and most liquid in the world. Plus, the U.S. dollar remains the reserve currency.
We are, however, entering a new period when investors will seek a structural higher term premium given America’s debt profile, and that has consequences. Besides rising interest expenses, this debt profile also makes us more exposed to confidence shocks. The world is a complicated place right now, and having the perceived safe-haven status of U.S. Treasury debt appearing not quite so safe as it was is less than ideal.
As we gear up for third-quarter earnings season, it may be the focus on U.S. deficits and debt wanes in favor of the exciting reports of leading-edge companies at the forefront of innovation posting ongoing blockbuster results. But in a few short weeks, Americans will head to the polls, and it is a good reminder to all of us that our choices matter. We need leadership in our government to find a path forward, carefully, compassionately and with a balanced approach that reaches across the aisle. We have done this before: the 1990s had examples with Presidents Bush and Clinton both working with Congress led by the opposing party. Can we again find common ground?
Wishing you a joyful fall weekend and hoping you have the chance to take a walk, pick an apple or visit with family and friends.
Written by a human.